Destination XL Group Inc (DXLG) 2016 Q2 法說會逐字稿

Good day, everyone, and welcome to the Destination XL second-quarter 2016 earnings call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Mr. Jeff Unger. Please go ahead, sir.

Good morning, everyone. Thank you for joining us today on the Destination XL second-quarter fiscal 2016 call. On our call today is David Levin, our President and CEO as well as Peter Stratton, our Chief Financial Officer.

During today's call, we will discuss some non-GAAP metrics to provide investors useful information about our financial performance. Please refer to our earnings release which was filed this morning and is available on our investor relations website at investor.destinationxl.com for an explanation and reconciliation of such measures.

Today's discussion also contains certain forward-looking statements concerning the Company's operations, performance, and financial conditions, including sales, profitability, EBITDA, gross margin, capital expenditures, earnings per share, free cash flow, store openings and closings, and the Company's ability to execute on its strategic plan and the effectiveness of the Destination XL concept. Such forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those assumptions mentioned today due to a variety of factors that affect the Company. Information regarding risks and uncertainty is detailed in the Company's filings with the Securities and Exchange Commission.

Now I'd like to turn the call over to our President and CEO David Levin.

Thank you, Jeff, and good morning, everyone. Before we get into the quarterly results, I'd like to take a moment to review with all of you where we are with the DXL transformation.

It's hard to believe that we opened our first DXL store in Schaumburg, Illinois, six years ago. Up until the opening of our first DXL stores, it was unheard of for a retailer to dissolve one brand and migrate its customer base to an entirely new concept without going through a sale or reorganization. Well, today, we have 187 DXL retail and outlet stores open across the country and we expect to grow that number to approximately 400 stores over the next 5 to 6 years.

There are a lot of retailers today who are downsizing because the landscape has become oversaturated with their stores. This is especially true in malls, where traffic has been declining for years.

And that's not true for DXL. We are catering to a niche that is underserved in retail. We believe we have an advantage as a destination concept and we are not dependent on mall traffic like many other retailers as our locations are located in strip centers off-mall.

Our customers come to us from all walks of life. They come from different ethnic and cultural backgrounds and all age levels. The DXL brand is not bound to a singular demographic or lifestyle.

Our brand was created to provide big and tall guys with a store of their own that has the desirable sought-after blend of quality, service, and selection. Our brand awareness has been steadily growing and we are acquiring a new smaller-waisted customer who spends more money and shops more frequently.

Fiscal 2016 is a milestone year for us as the leverage in our financial model begins to swing in our favor. This will be the first time in four years that we will have generated positive free cash flow and the top end of our earnings guidance is to breakeven.

For the second quarter, we delivered growth in both sales and profitability in a very challenging consumer environment. We believe our performance, while much better than the industry overall, was tempered by an increased level of economic and political uncertainty. That uncertainty leads us to caution, which influences our customers' shopping habits.

Macroeconomic factors notwithstanding, we had a solid Q2 performance. DXL retail stores delivered a comp sales increase of 4.6% on top of 11.9% comp a year ago. This gives us a 2-year stack comp of 16.5%, of which we are very proud of.

Total second-quarter sales increased 3.3% from a year ago. We produced a net income of $200,000 versus a net loss of $1 million a year ago. EBITDA for the quarter was $8.5 million, up 26% from the second quarter of last year.

We delivered positive comps for the 13th consecutive quarter, increasing sales, cash flow, and profit, even against a very difficult retail environment. And on per-customer basis, all the major metrics we track improved year over year.

In terms of the transformation plan, we opened six DXL retail stores and one DXL outlet this quarter. There's still many markets across the country that have now just been introduced to DXL. So far this year, we've opened our first DXL stores in new markets such as Lexington, Kentucky; Davenport, Iowa; Buffalo, New York; and Ann Arbor, Michigan.

We also continued to fill in existing DXL markets with new stores this year in Los Angeles, Philadelphia, and Houston. We remain on track to open approximately 31 DXL stores this year, consisting of 28 retail stores and 3 outlets.

Awareness of the DXL brand has continued to grow, generating a year-over-year increase of 9% in the rate of casual male customers converting to DXL. At the same time, the valuable end-of-the-rack customer share of our bottoms business rose again, to 44.1% from 42.9% in Q2 of 2015.

We see these positive trends in other metrics as well: number of transactions, items per guest, average spend per guest all rose from the second quarter a year ago. As a result, sales per square foot has steadily increased to $181 per foot on a rolling 12-month basis, a 5.2% increase from a year ago.

The growth in brand awareness has had a direct effect on the performance of our newer DXL stores. The newer generation of stores has outperformed its predecessors and our plan, largely because more people know about DXL. Our newer DXL stores this year are already ahead of plan on sales, profit, and return on invested capital.

We are also learning more about where we are getting the most of our marketing spend. Without question, we are seeing a shift in productivity between television, radio, and digital marketing.

Recognizing the shift will enable us to target our marketing where it's most effective, which is leading to lower SG&A expenses. For example, in Q2, we reduce marketing expenditures by $500,000 to 6.5% of sales compared to 7.2% of sales a year ago. For fiscal 2016, we're lowering our goal for marketing expense to approximately 4% of sales, an improvement of 100 basis points from 5.3% of sales in 2015, an approximate savings of $5 million.

In closing, our belief in the DXL transformation has never been stronger. The DXL customer is buying more and spending more per transaction, and our average sales per square foot continue to climb.

However, we have seen our customers become more cautious in Q2 and our sales forecast for the rest of the year reflects that trend. We are confident in our ability to leverage our operating model despite the moderated sales expectation, and we are confident that we will continue to produce growth in revenue, earnings, and EBITDA.

Our EBITDA has grown from $7.3 million in 2013 to $15.2 million in 2014 to $23.3 million in 2015 and we expect it will be approximately $31 million to $35 million in 2016. The prospects for Destination XL are truly exciting and we look forward to bringing you signs of our progress when we speak again next quarter.

And on that note, I'll turn it over to Peter to review our financial performance.

Thank you, David, and good morning, everyone. As David just mentioned in terms of the DXL transformation, we are on a solid foundation both operationally and financially.

As we've been saying for the past few years, fiscal 2016 is a pivotal year in the financial transformation of DXL. We've been waiting for the crossover point, which we expected to be this year, where the Company can generate enough free cash flow to fund our DXL store openings and also begin to pay back some of the debt we incurred in order to finance the store buildout in the earlier years. I'm very happy to report today that despite the consumer headwinds David mentioned earlier, we are still on target to achieve that goal in fiscal 2016.

So let's move on to the second-quarter results. This was a good solid quarter for us, despite the macro uncertainty. Overall, our financial performance for the second quarter was positive. This is the first time in four years we've delivered positive earnings for the second quarter instead of a net loss.

During the second quarter, we reported a total comparable sales increase of 2.4% and that was on top of a 6.7% increase in the prior-year quarter. We had 151 DXL stores open for at least 13 months, which delivered a comparable sales increase of 4.6% on top of an 11.9% comp sales increase in Q2 2015.

The number of DXL transactions increased 3.2% from the second quarter of last year, helping to drive our comp sales growth. But this increase was slightly below our expectations.

In the second quarter, gross margin including occupancy cost was 46.5% compared with 47.2% for the second quarter of fiscal 2015. The decrease of 70 basis points was the result of a 110-basis-point decrease in merchandise margin, which was partially offset by a 40-basis-point improvement in occupancy costs as a percentage of sales. The improvement in occupancy cost was primarily due to leveraging a higher sales base against relatively fixed occupancy expense.

Before we move on, let me briefly explain the decrease in merchandise margin. Every year, our planning and allocation team initiates a process to roll some of our slow-moving inventory from full priced to clearance. We call this rolling the dots.

And when we roll the dots, we see an increase in markdowns flow through to our P&L as our clearance levels get replenished and we see a spike in clearance sales. In 2015, we rolled the dots in the fourth quarter, and in 2016, we rolled the dots in the second quarter. Thus, there is a bit of a timing adjustment coming through this quarter in markdowns that will normalize in our full-year results.

Looking at the remainder of fiscal 2016, we expect merchandise margin to decline in Q3 this year from Q3 last year because of the dot role. In addition, we are adding one more promotional event this year, which will add some markdowns in Q3, but Q4 merchandise margin will be better than last year, mainly because of the rolling the dots that I just explained.

So moving on to SG&A, we continue to be disciplined with controlling costs in this area. Our SG&A costs for the second quarter were 39.3% of sales compared with 41.3% a year ago. On a dollar basis, SG&A expense declined $800,000 from Q2 2015, primarily due to a decrease in advertising costs and incentive accruals.

When sales began to trend lower than our historical pattern earlier this year, we responded by tightening expenses. This strict control over SG&A spending is what has allowed us to maintain our full-year EBITDA and EPS guidance despite lower sales expectations for the year.

Going forward, we'll continue to reduce SG&A as a percentage of sales, but at a slower rate than what we've seen this year. Our SG&A improvement in 2017 should not be as dramatic as what we are now expecting for full year 2016 because of this shift in expense management.

Net income for the quarter was $200,000 or breakeven per diluted share compared with a net loss of minus $1 million a year ago. Net income on a non-GAAP basis, assuming a normalized tax rate of 40%, was also breakeven on a per-share basis, up from a net loss of $0.01 per share in Q2 of fiscal 2015.

EBITDA was $8.5 million, up from $6.8 million in the comparable quarter in 2015 for an improvement of [26%]. Capital expenditures for the first 6 months of 2016 were $13.8 million, down from $17 million in the second quarter of 2015. The lower CapEx was due to opening 12 stores through Q2 of 2016 as compared to 18 stores through Q2 of 2015. As of July 30, we have a total of 176 DXL retail stores and 11 DXL outlets opened across the country.

Inventory at the end of the second quarter was down $2.3 million or 1.8% from second quarter 2015. The lower inventory level is a direct result of the inventory initiatives we discussed on our Q1 call to improve timing of receipts and weeks of supply on hand. Clearance merchandise was 7.7% of our total inventory for the second quarter of 2016 compared with 7.2% of inventory for the same quarter in 2015.

Total debt at quarter end was $63.6 million, which includes borrowings under the revolving credit facility of $41.2 million, with excess availability of $66 million.

Finally, let's turn to our 2016 guidance. The Company is revising its full-year sales guidance for fiscal 2016. However, our current EBITDA and earnings-per-share expectations remain within the range of our previous guidance for fiscal 2016 as a result of our disciplined SG&A expense management that we've discussed on this call.

For the 2016 fiscal year, we now expect total sales in the range of $457 million to $463 million compared with our previous guidance of $465 million to $472 million, a total Company comparable sales increase in the range of approximately 2% to 4% compared with our previous guidance of 4.8% to 5.5%, gross profit margin at the low end of the range of approximately 46.2% to 46.5%.

The remainder of our guidance for fiscal 2016 remains unchanged. We still expect an adjusted net loss of minus $0.05 per diluted share to breakeven, assuming a normalized tax benefit of approximately 40%. EBITDA in the range of $31 million to $35 million. Capital expenditures of approximately $30 million with approximately $20.6 million invested in new DXL stores.

Borrowings at the end of fiscal 2016 in the range of $59 million to $64 million. GAAP cash flow from operations of $35 million to $40 million, and free cash flow before DXL capital expenditures of approximately $25.6 million to $30.6 million, resulting in total free cash flow in the range of $5 million to $10 million.

Finally in 2016, we continue to expect to open approximately 28 DXL stores and close approximately 26 casual male retail stores and three casual male outlet stores.

In closing, we are confident in our ability to leverage our operating model in the current uncertain retail environment. We continue to make progress across the business and we look forward to the second half of a pivotal year where free cash flow turns positive and we begin to pay down our debt.

And with that, operator, we will open the call for questions.

(Operator Instructions) Greg Pendy, Sidoti.

Thanks for taking my question. Can you just kind of go into I guess within the reduced sales guidance, kind of where you are seeing that from a customer base. I know last quarter, you kind of mentioned that, you know, a certain -- more of the wear-now customer was a little bit absent.

But can you just kind of give us a little bit more color on where you see the pockets of strength and where the pockets of weaknesses are within the lowered sales guidance? Thanks.

Yes. We look at all our key metrics. So in the current quarter, our transactions, our spend per guest, items per guest, casual male conversion, end-of-the-rack growth, sales per square foot were all meeting and exceeding our expectations.

So we clearly don't see this as a DXL problem. It's more of that macro issue, the uncertainty. And in the scheme of things, we've taken our sales down about 2%, and we think that that's going to have an impact probably in Q3.

We don't know about Q4 yet, but we are just taking this conservative approach. But we've seen no other behavior of our existing customers other than some of them are holding back and making their trip to our stores.

But outside of that, we are very confident that we are not -- we don't really need to tweak our model or make any changes to the promotional schedule we have to get through the rest of the year.

That's helpful. And then if I could just get one more question, is there any update? I know it's a ways out, the projections, but just on the international franchising opportunities?

No, we don't have any updates at this time, other than we will be entering in the Canadian market next spring. We are finalizing our leases right now.

And on the international part outside of North America, it's a lot of discussions. We've made several trips around the world and talking to a lot of interested investors. But it's a slow process, and we are walking through it very conservatively and making sure we find the right partners.

That's helpful. Thank you.

Bernard Sosnick, Madison Global Partners.

First I'd like to say each time I read your press release in the quarter, I'm impressed. And you do a very good job, as you just did with the summation -- verbal summation. So thank you for that.

With regard to sales, retailers saw weak sales in the first quarter. And that quarter ended with sales weak after having been more robust early in the first quarter. The same was happening with you.

But during the first-quarter call, your -- you noted that your sales weakness was in the east and it still hadn't brought in the seasonal shopper. The weather turned better, and I'm wondering what the rhythm of sales was month by month during the quarter.

Sure. So that's right that in the first quarter, we definitely saw performance was a little bit better in our warm climate stores. In the second quarter, what we saw really across the country was May was a weak month, June got a bit stronger, and then it softened up again in July.

So I think as David just alluded to, the people that are coming into the store, the response has been very positive. It's more the sales shortfall or the reduction in sales guidance was more due to the fact that we've just seen a bit of a slowdown in traffic, which I think a lot of our other of our peers are noticing as well.

So that leads us to believe that it's not anything to do with the DXL concept. It's more the macro issues that are surrounding us right now.

All right. So in other words, you didn't get as much lift when the weather turned warm in the east as you had expected. And the goods for clearance at the end of the first quarter was somewhat higher than a year earlier.

And you ended the second quarter in the same situation, despite taking heavier markdowns and accelerating the markdown pace. Could you give a little bit of enlightenment about the clearance issue?

I mean, it's really a nonissue for us. It's strictly a matter of timing. Because when we roll our markdowns, they fall into the clearance. So by taking them earlier, it was just a higher percentage, not significant. 9.7 versus 9.2 a year ago.

That will all catch up by the end of the year. So that really to us is a nonissue. We don't really have any more clearance than we did a year ago. We haven't taken any more aggressive markdowns than we did a year ago. It's really just a matter of timing. You'll see it here. It will wash out.

Well, I want to congratulate you on the steps with inventory control in the back room and expense control. And getting to the crossover point this year, let's hope. Thanks.

(Operator Instructions) Eric Beder, Wunderlich.

This is Bryan Caronia on for Eric. The first question we had was we were hoping you could give some insight into the cadence of performance across product segments within the stores, specifically noting perhaps how suiting did.

But overall, I would certainly be interested to see if there was any deviation or distinction between performance amongst tops and bottoms and different fashion trends over the last few months.

Okay. Clearly our suiting business, which we will have our suits, sport coats, dress shirts, ties, dress pants, has been the stellar performance for us. And that's really a result of when we open a DXL store, we have a much bigger presentation in the clothing area than we did in our casual male stores. So they get a dramatic lift.

Again, in our old casual male stores, they may have a choice of two or three options in buying a suit. And we have a full suit selection and sport coat selection in the DXL stores. That remains consistent.

Our footwear business is very strong, and outside of that, everything is pretty predictable. We are definitely seeing some great movement in our younger men's styling and we are chasing that product. Actually, it's more of a West Coast phenomenon, but it's starting to shift throughout the country.

And that's great for us, because this clearly is a younger customer that, again, the DXL is starting to certainly cater more to that guy as the age of our customer comes down. But those are the highlights.

Great. And I guess as an extension of that, even if it's not, I guess, specifically quantified numbers, do you have any insight in terms of the split and I guess sales trends of the products being branded or private label? And whether that is commensurate or perhaps a bit deviated from what your long-term plans are in terms of trends in other segment and product mix?

Yes. So right now, we are 55% branded, 45% private label. That is going to remain pretty consistent. It may be moving a point or two per year, but we have so many stores opened right now, we really pretty well have that balance laid out.

So I think branded may grow as a percent, but nothing dramatic. I think we've got it -- and again, our private label still is a big driver of our business, regardless of the locations throughout the country.

Perfect. Thank you very much and I'll step back in the queue.

Chris Krueger, Lake Street Capital Markets.

Can you talk a little bit about how your smaller units are performing? The ones that allowed you to kind of enter smaller markets and kind of fill in some larger markets?

Sure. The small format stores have been performing very well. I think as many of you know, that's one of the key reasons why we've been able to grow our long-term projections to get to 400 stores is because that smaller store allows us to penetrate so much more deeply across the US.

But they've been performing very well. In fact, in 2015 and 2016, most of the stores that we've opened this year have been performing beyond their initial projections.

So we think part of that is due to the fact that these stores opening today are benefiting from the higher brand awareness that we have out there versus the stores opening a few years ago didn't have that benefit. So they are still doing very well, still on track, and they will be the substantial portion of stores that we are opening going forward will be that smaller format.

Okay. And as you look ahead to the next few months with your advertising spending, how do you look at that this year versus last year as far as spending levels and also the timing of your ad spend?

A good part of our ability to maintain our earnings is we have lowered our marketing expense. And we were driven by TV, radio -- very expensive; not very targeted. And we've seen really a seismic shift in how our customers are responding to our marketing.

There's something dramatic going on and we're trying to get ahead of it. Our smartphone traffic is up 42% this year from a year ago, and our online revenue from the smartphones are up over 30%. So now over 50% of our traffic is coming from mobile versus 40% a year ago.

So we are making a conscientious, aggressive move to go off of the TV/radio marketing and move more into a digital world. This is really not a lot different than when we were a catalog house with 16 drops a year a few years ago. We got rid of the catalog. We replaced all that business.

And we really feel a shift into digital is where customers are moving. It's much more targeted. It's much less expensive. Our cost per thousand views is $10 versus TV was $30. So yes, that's where we are going to be spending our money going forward, and it also allows us to protect our earnings more.

Okay. And the last question: anything new on the competitive front as far as other concepts or other brands or -- anything there?

No. Certainly in brick-and-mortar, we don't anticipate anybody trying to come at us from a competitive point of view. There's always more on the Internet, but nothing that we've seen that we can identify as changing our percentage of market share on the Internet at this time.

All right, thanks. That's all I got.

(Operator Instructions) Bill Caton, First Wilshire.

Curious -- on the end-of-the-rack customer, I see your bottoms business continues to grow with them, up over 44%. Is there any statistics you could give around -- are these guys only going into buy bottoms? Or are they buying other things in the store? And what are just some statistical trends on the end-of-the-rack, if you could share any more information?

Sure. First of all, the only reason we identified bottoms is because it can kind of distinguish what size this guy. Our tops are little more challenging for us, so that's just an indicator. But it's across the board, spending is going on.

And the most important thing is when we designed this DXL concept, we wanted to get this end-of-the-rack guy in our stores. But we didn't really understand how powerful he is.

So our current trend is -- the guy who is 40- to 46-inch waist is spending 100% more than the guy from a 48-inch and up. So he's really worth two of our customers. He is shopping 46% more than our guy who is 48 inch and up.

So this has been a huge win for us. And to me, the exciting part is today, only 4 out of 10 guys that size have ever even heard of DXL. And as they -- as the marketing and the awareness grows, once he comes in the store, he loves what he is seeing. And he's going to be a loyal customer for a long time.

So we've got a lot of blue sky out there to really grow this customer, because again, it's all about awareness. Once we get him in, we own him.

Okay. So the end-of-the-rack guy is 40% type of a brand name recognition or customer awareness. And the 48 inches and above, what is the -- in terms of brand name recognition, DXL versus your older-generation casual male, is there a -- what's the breakdown on that?

We don't track it anymore. But casual male awareness was over -- I think closer to 60%. So again -- and we haven't marketed casual male since we started the DXL. We haven't put any of our marketing money there because all the stores are going to be converting over.

Okay. And in light of weakness in consumer confidence -- or I don't know if that's a new story, but if that continues to persist, linger longer term, would you consider not rolling out as many stores or extending the rollout? Or you feel you are sticking to the plan, despite any macro headwinds, absent anything drastic?

We are not at that point yet. We're planning on opening quite a few stores next year. Those are in the queue already. We feel very good about it.

Again, the new stores are doing the best of any of our stores. They are clearly beating our projections. So we're going to continue on this path. Again, depending on what happens out there in the world, certainly we may change. But right now we have no plans to deviate from our current strategy.

And one thing that I would just like to add is we talked a little bit about our positive free cash flow that we are going to have this year. This is the first time in four years that we are going to be generating significant positive free cash flow of $5 million to $10 million this year.

And we've seen it in our Q1 and our Q2 results. We are profitable on a bottom-line basis year to date. So despite some of the weakness on the top line, we think that we've made the right corrections to ensure that cash and the bottom line come in where we are expecting them to come in.

Okay. Well, thank you. Congrats on the profitability this quarter. Good quarter; thank you.

And we have no further questions in the queue at this time.

Okay. Thank you all for joining us today. And as I said before as a reminder, I really -- we are open to invite all of you to visit one of our DXL stores and experience what we've built into our concept.

And if you'd like to visit any of our stores, please let us know and we'll be happy to give you a tour. We look forward to speaking with you next quarter and have a great day.

Again, that does conclude today's presentation. We thank you for your participation.